Markets back to square one

The wheel has come full circle. The Sensex is now just a whisker above its closing low of 13,989 reached on 21 August 2007. The US credit crisis first reared its head in late June last year and most markets plunged to their lows in August before pulling back. Most developed markets are in fact trading well below their August levels.

For example, the Dow Jones Industrial Average (DJIA) closed at 11,842 on Monday, well below its August low of 12,455. Both London’s Footsie and Frankfurt’s DAX have plumbed much lower depths than their August lows. Ditto for Tokyo’s Nikkei.

Unlike the Sensex, these markets reached much lower levels in January and March this year than during last August.

That’s because the initial reaction to the credit crunch was a rush of money to Asian markets, under the belief that they would be insulated from the crisis. As a result, these markets moved up sharply in the last quarter of the year before starting their long slide this year.

Within this Asian pack, there are several countries where the benchmark indices have slid below their August lows. The Shanghai Composite Index, for example, is currently 34% below its low point in August. Taiwan’s benchmark index too is currently below where it was in August. But the Hong Kong, Indonesian, Malaysian and Korean indices are still trading above their lows.

Brazil’s Bovespa index is a study in contrast—at its close on Monday, it was trading at 64,640, 43% above its August lows.

These numbers tell the story of what’s been happening to the world economy in the past year. The credit crunch has hit the West hard, which is why DJIA and the Footsie have fallen far more than the Sensex from their levels at the end of May last year. Markets such as China and India, which are large importers of commodities, have also been hit badly. And commodity exporters such as Brazil have done splendidly.

Investments have buoyed the Tata Power stock

Tata Power Co. Ltd has been the best performing power utility stock this year. It’s fallen by 32% from its peak in January, about half the rate at which Reliance Power Ltd’s valuation has dropped. Reliance Power was valued at Rs1.02 trillion at the time of its initial public offering, but has now fallen to around Rs40,000 crore. NTPC Ltd’s shares, too, have fallen a higher 46%.

One of the reasons for the lower drop in Tata Power was that nearly 60% of the company’s current valuation is accounted for by investments in Tata group companies, cash in hand, and the investment it made in two Indonesian coal mines owned by PT Bumi Resources Tbk last year.

Based on a conservative 40% discount to market price for each of these investments (except, of course, cash in hand), their cumulative value works out to around Rs700 per share.

The $1.1 billion (Rs4,719 crore today) investment made to acquire a 30% stake in the Indonesian mines has been rather fruitful—in the past two months, marketable coal reserves of these mines have risen by 69% thanks to new discoveries. This investment has been valued at about Rs400 per share by analysts applying a 40% discount to market price and about Rs530 by those applying a 20% discount.

But accounting for the stake in this fashion may not be appropriate—the mines already add considerably to the company’s consolidated profit. Accounting for the stake separately could amount to double-counting, says an analyst.

The minority share in the mines has accounted for about 20% of consolidated sales and about 24% of consolidated profit before interest and tax.

The $75 million dividend received from these entities also came as a positive surprise. And note that the stake in Bumi was picked up by the company to primarily ensure supply of coal for the large power plants it has planned.

So, it perhaps doesn’t make sense to value it as an investment.

According to Alchemy Share and Stock Brokers Pvt. Ltd, “Bumi Resources should be valued as part of consolidated numbers and valuation metrics rather than as a tradable investment, primarily because it was bought to ensure adequate coal supply and not to trade.”

If one were to subscribe to this view, Tata Power’s valuation suddenly looks expensive by about Rs400 (Bumi’s contribution to its valuation). This could be the reason the stock fell by about 6% on Tuesday, as the results had no negative surprises.

As far as Tata Power’s main business is concerned, the outlook is rosy.

Power generation capacity is expected to increase sixfold to about 12,831MW in 2014 from 2,400MW. What has enthused analysts and investors is that work is progressing fast and orders for critical components have been placed for some large projects. The Mundra ultra-mega power project of 4,000MW and the 1,050MW Maithon power project have achieved financial closure and equipment orders have been placed.

US banks back to 1997 levels

After Tuesday’s piece about the S&P 500 financials index going below its March lows, a fund manager pointed out that the BKX index, which is the most widely followed bank index in the US, has broken the low it reached in 2002. The BKX chart in Yahoo.com shows the index at 60.87 on 23 June. The last time it was at that level was in May 1997. Thanks to the credit crisis, US bank valuations are now at the level they were at over a decade ago.

The trouble is that problems within the big banks are certain to have an impact on global liquidity. That’s because bank funds are a big source of funding for players such as hedge funds. As banks scarred by the subprime meltdown tighten their lending norms, not only will it slow growth in the US, but it will also lead to less liquidity for other borrowers. And since the boom of 2003-07 was built on liquidity, the bust too will be accompanied by it.